Lecture 6

Exchange Rate and Currency

• An exchange rate is the price of one country's currency in terms of another country's currency.
• The exchange rate regime matters because it affects the stability and volatility of the economy.

European System of Central Banks (ESCB)

• The primary objective of the ESCB is to maintain price stability.
• The ESCB is composed of the European Central Bank (ECB) and the central banks of the EU member states.

Eurosystem and Inflation

• The Eurosystem's target inflation rate over the medium term is below, but close to 2%.
• The ECB pursues price stability through monetary policy, using instruments such as the main refinancing rate, the marginal lending rate, and the deposit rate.

Interest Rates and Exchange Rates

• The euro short-term rate (€STR) is based on the wholesale euro unsecured overnight borrowing rate.
• Interest rate parity is a condition where the difference in interest rates between two countries is equal to the expected change in the exchange rate between the two countries.

Inflation and Consumer Prices

• Inflation is a sustained increase in the general price level of goods and services in an economy over time.
• The Harmonised Index of Consumer Prices (HICP) is a measure of inflation used by the ECB.

Euro Adoption and Currency Areas

• The exchange rate stability criterion for euro adoption is that the country's currency should have been a member of the ERM II for at least two years, with a stable exchange rate.
• Countries expected to join the monetary union and introduce the euro are EU member states that have not yet adopted the euro.
• The European Financial Stability Fund (EFSF) provides financial assistance to EU member states experiencing financial difficulties.

Money Market and Interest Rates

• Money market rates are the interest rates at which banks and other financial institutions lend and borrow money.
• The three rates set by the Governing Council of the ECB are the main refinancing rate, the marginal lending rate, and the deposit rate.

Currency Areas and Shocks

• An asymmetric shock is a shock that affects one country or region more than another, making it difficult for a common monetary policy to respond.
• The three classic economic criteria for an optimal currency area are labor mobility, fiscal transfers, and price flexibility.
• A currency area becoming more diverse can lead to potential costs, such as increased difficulty in responding to asymmetric shocks.

Exchange Rate Regimes

• A fixed exchange rate regime is where the central bank pegs the exchange rate to a fixed value, while a managed floating exchange rate regime is where the central bank intervenes in the foreign exchange market to influence the exchange rate.
• A free floating exchange rate regime is where the exchange rate is determined by market forces, without central bank intervention.

Other Key Facts

• The interest rate parity condition is a condition where the difference in interest rates between two countries is equal to the expected change in the exchange rate between the two countries.
• A depreciation of the domestic currency can lead to an increase in production costs if some inputs are imported, and can make exports cheaper for foreign buyers.
• A domestic currency appreciation can lead to a decrease in competitiveness, as exports become more expensive for foreign buyers.
• The ECB has used unconventional policy instruments, such as quantitative easing and negative interest rates, since the financial crisis.

Test your knowledge of EU inflation rates and consumption patterns with this informative quiz. Explore the factors that influence the overall shopping basket in different countries and see how inflation rates have fluctuated over time. Perfect for anyone interested in economics or current events.